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The UK wealth market (i.e. my market) is primarily focussed on public investments. There are a couple of good reasons for this. First, public markets are liquid so if at any point you change your mind you can always have your money back. Second, the UK wealth market is pretty heavily regulated and the regulator (the FCA) would much rather we invest in publicly traded assets as these have their own sets of investor protections (audits, quarterly investor calls, listing requirements built in). It is harder to really go wrong if you stick to public markets.
That said, too much regulation can restrict choice and stifle innovation and the FCA is aware of this. It has therefore set up Long-Term Asset Fund vehicles (LTAFs) which are available for UK individuals and which give access to the sorts of asset classes (private equity, infrastructure, private credit) that were previously only available to private market investors.
And it falls on people like me to assess if they would be good options for our clients. I like to keep these notes on the shorter side so I am glossing over a lot here (like how LTAFs actually work, what private credit actually is etc) so if you’d like to discuss this further please do get in touch. But with that proviso I think there are a couple of good reasons for us to look at LTAF/private market opportunity more closely:
- These are high alpha investments and if you good managers have generated public equity beating returns. Private equity investors are generally more hands on in identifying opportunities, cutting costs and transforming business. And private credit managers should, I think, do a better job of managing loans to businesses that run into trouble. Public market investors often run for the exit (and sell to distressed debt specialists at low prices) at the first sign of real trouble. Private credit investors are much better equipped to deal with the sorts of problems that lenders inevitably face from time to time.
- Your return is generally driven by the Net Asset Value (NAV) of the business rather than the price a tiny part of it just traded on the New York stock exchange. This is attractive! US equities have just fallen over 10% in the last three weeks. I can assure you that all the private market investments out there (and there are over $10 trillion of them globally) will be flat or up a bit for March. Of course, over the longer term private and public market valuations need to line up. But in the short term, the fact that LTAF valuations won’t yo-yo up and down with every Trump announcement makes them pretty attractive for allocators like me.
If those are the pros, private markets also come with a couple of obvious disadvantages:
- High investment alpha normally comes with high fees. And standard private equity fees (a 2% management charge and 20% of the returns earned) are eye-wateringly expensive especially when you come from a world where you can buy diversified equity ETFs for less than 0.1% p.a. That 20% performance fee is particularly egregious when you consider (i) asset prices normally rise over time so you don’t need that much skill to grow a valuation and (ii) part of the return just comes from adding debt to the business and so making the whole thing riskier. There are of course a lot of talented private equity managers out there but these fee levels mean even some of the better ones don’t deliver attractive net returns.
- If private market valuations are at their NAV and public market valuations are moving around all the time the obvious question for me is which is cheaper? Today I think the answer is public markets. One reason I think this is that we have seen very low levels of IPOs (so sales of private companies to public markets) for the last few years. One obvious reason for this would be that private market valuations are higher than public ones today. Conversely, we are seeing plenty of public companies being taken private. As an example, in some of our client portfolios we own a listed real estate trust (Care REIT) that invests in UK Care Homes. In spite of very solid performance and the REIT paying a yield over 8% it was trading at around a 30% discount to its own NAV. It was bought this week by a US investor at a 33% premium to the closing price.
So the better opportunity to us today looks to be in unloved public market investments (like UK investment trusts) that have the potential to be taken private. However, markets are always moving and at some point, no doubt, there will be good opportunities on the private side. We are therefore doing the work now to start looking at the LTAF market and see what it can offer. In the short term, we very much like where we are in public markets but in the longer term things of course change. The good news is that the growth of LTAFs means we can look properly at private markets if they do.
Note, LTAFs and Private Equity / Credit investments are high risk investments that are not suitable for all investors. If you are seeking to invest in these types of investment products you should seek financial advice prior to making any investment decisions. This note is not intended to represent any form of advice nor is it intended to be any form of solicitation to enter into investment activities in these types of products.
Chris Brown, CIO
cbrown@ipscap.com
The value of investments may fall as well as rise and you may not get back all capital invested. Past Performance is not a guide to future performance and should not be relied upon. Nothing in this market commentary should be read as or constitutes investment advice.
